The best time to buy or sell stocks – Market Timing and the Efficient Market
This is a good article by James K. Glassman about market timing and the efficient market. It is definitly worth a few minutes of your reading time.
Steve
Published: November 12
In a time of market turbulence, with stocks losing altitude, it’s only natural to feel compelled to buy and sell according to your own forecasts of whether a stock — or the market as a whole — will rise or fall in the short term. My advice: Resist!
Unfortunately, the urge is strong — almost irresistible. It looks easy in hindsight, and the results are spectacular. Let’s pick a stock at random: Waters, a midsize manufacturer of high-tech equipment, such as liquid chromatography systems. Waters is not an especially volatile stock, yet in nine of the 12 years starting in 2000, its yearly high has been at least 50 percent higher than its low. In 2000, you could have bought 1,000 shares at $22, sold them in 2001 for $85, bought them back again in 2003 for $20 and sold them in 2011 for $100. Total gain: $143,000. But if you had bought the stock at the start of 2000 and held it continuously through Sept. 9, 2011, when the shares closed at $75, you would have earned just $53,000.
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Or consider the U.S. market, as represented by SPDR S&P 500, the popular exchange-traded fund that tracks the Standard & Poor’s 500-stock index. If you had $10,000 in Spiders at the start of 2001, you would have had $11,519, including reinvested dividends, at the end of 2010. But if you had pulled your money out at the start of 2001, 2002 and 2008 — all down years for stocks — stuck the cash under the mattress, then reinvested the money at the start of the years that produced gains, you would have had $26,316.
Efficient-market hypothesis
Market timing — the term for the process of moving in and out of assets according to predictions of what their prices will do next — looks like it can be a hugely successful strategy. So might the strategy of guessing the numbered slot into which a roulette ball will fall after the wheel is spun. The only problem is that most mortals can’t time the markets consistently well enough to make the strategy worthwhile. And because of the vagaries of human emotions, the act of trying to time the stock market often produces far worse results than just buying a diversified bundle of stocks and holding them for the long haul. People tend to sell in a panic at the bottom and buy in a flush of confidence at the top.
John Bogle, founder of the Vanguard Group of mutual funds, wrote of market timing: “After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently. I don’t even know of anybody who knows anybody who has done it successfully and consistently.”
The reason is that markets are efficient. University of Chicago economist Eugene Fama first formulated the efficient-market hypothesis in his PhD thesis: “In an efficient market, competition among the many intelligent participants leads to a situation where, at any point in time, actual prices of individual securities reflect the effects of information based both on events that have already occurred and on events which, as of now, the market expects to take place in the future. In other words, in an efficient market at any point in time the actual price of a security will be a good estimate of its intrinsic value.”
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